Why We Fail

Since I formed a goal to turn this dismal statistic around (well, at least to improve it), ‘why’ it should be so, has fascinated me.

Sure like any profession, law, medicine, architecture, etc., trading success requires an education; then we need to turn that education into a skill-set.

On the other hand, the knowledge required for trading competence is relatively small when compared to other professions. It’d be impossible to acquire the knowledge we need, for example, for law, in less than four years. Acquisition of trading knowledge, on the other hand, is possible within a 6-month window.

So what’s different for trading?

I think part of the problem lies in the nature of trading. More than any other profession, its results, on a trade-by-trade basis, are totally random.

This means ……….

You may not know anything about trading, but, you may still make money – if luck favours you. Indeed, you can make a lot of money if luck favours you, because luck may bestow herself on more than one trade; you may enjoy her blessings on a series of trades!

But, of course, luck eventually leaves. The newbie, misinterpreting luck for competence perseveres and, in the process, returns all the profits and more. I went down the road often enough in my early years to know its truth.

Another part of the problem lies in the educational environment.

Imagine an ad for a law degree that promises to turn you into a Perry Mason instantly. It’s unlikely that it would be very successful.

But ads promising instant success – instantly turning “a few dollars to mega dollars all because of System z” – abound. I assume they abound because we buy them in enough quantities to encourage continuation of the tripe. Now add to that the fact blurbs, promising hard work in return for success, seem to be less successful in attracting students. The effect of the education is we have newbies trading a method which even if strictly followed, has no chance of making money over a large sample size.

The final problem lies with a lack of appreciation that to succeed traders need to be adequately capitalised. In a sense, this is an issue of knowledge: what capital ought we start with to give us the best chance of success?

Nowadays in my part of the world, the matter is not such a great hurdle.

Capitalization is a function of our trading stats and the volatility of the instrument or asset class we are trading. Since we don’t have the necessary stats when we first start, we make do with ‘volatility’.

One of the better formulas available is the Turtle’s formula:

($ value of % Capital to risk)/($ Value of the 14-period Average True Range).

The formula does not quite eliminate the need for personal stats because the % of Capital to risk is dependent on our results. Still, based on experience, a risk of 1% to 2% per trade would be sound.

With that info in hand, let’s see what capital we’d need to trade one contract in the e-mini:

ATR: 19

Point value: $ 250.00

2% risk: $ 2375.00

Capital required: $475,00.00 (!!)

I wonder how many trading the e-mini have that sort of capital?

I said ‘adequate capital’ is not such an issue in this part of the world. The reason is we don’t have to trade futures, we can trade CFDs. And, the regulatory environment is such that traders receive as much protection (if not more) as futures traders in the US and UK.

Essentially, what CFDs do is allow traders to trade smaller size.

A survey of CFD brokers shows contract sizes ranging from $1.00 per point to $5.00 per point. At 1.00 per point, we’d need USD 950.00 per contract, at $5.00, we’d need USD 4,500.00 per contract. The amounts are within the purview of the newbie.

(The Turtles Formula would not be the only factor limiting position size, we’d also have to consider the margin dictated by the regulators and the brokerage house).